This blog post was originally written at the request of the German-Armenian Journal Armenisch-Deutsche Korrespondenz, and is part of a series of previously unpublished blog posts and articles which will be pressed in the coming days…

article below…

PFA report’s cover

The findings in Policy Forum Armenia’s (FPA) February 2012 report caused quite a stir in Armenia. The document claims that the Armenian authorities have failed to implement a comprehensive policy shift in the wake of the 2008 economic crisis, and also that the country is likely to face a similar crisis in the future if appropriate action is not taken. This caused urgent concern for some, while being dismissed as alarmist by others. However, it is important to properly contextualise this report as well as the implications it puts forward. This being said, regardless of the accuracy of the report’s timeframe, the concerns highlighted by the FPA remain valid, and should immediately be addressed by the Armenian government, or lobbied for by local and international Armenian groups in order to ensure Armenia’s future prosperity and sustainability.

More recent reports by the World Bank and the International Monetary Fund (IMF) have put forward scenarios that somewhat contradict some of the bleaker predictions advocated by the FPA report. This does not mean, however, that the concerns and proposed recommendations of the report should be ignored. On the contrary, they should be taken all the more seriously, given Armenia’s already precarious geopolitical positionand the lack of space for mistakes in policy making.

Although Armenia may not necessarily be heading for a crisis as described in the FPA’s 3rd drastic currency depreciation scenario, many factors still hamper real and sustained economic growth – factors which in effect would only require willpower on the part of government authorities to solve. The solution ultimately revolves around a simple formula of a low, comprehensible and flat taxation system coupled with a sustained desire to tackle corruption at all levels, and finally, access to proper continuing education for Armenia’s citizens.

Interestingly, the report also reserves a role for the Armenian Diaspora in the pressure for, and implementation of, new and comprehensive pro-growth policies in the Republic of Armenia (RA).

Inflation and Debt Management:

Inflation and debt management are generally considered to be high priority concerns to ensure the macroeconomic stability of the country. The FPA thus rightly points out some of the dangerous flaws in the RA’s debt management policy, stating, for instance, that Armenia’s debt percentage has reached critical levels for a developing economy at 40% (p.4), while pointing out that Armenia is due to repay its foreign loans between 2013-2014 (most of which is owed to the World Bank). Such a process could potentially undermine Armenia’s foreign exchange reserves for a long time to come.

Though this is not entirely incorrect, it is well within the norms of sustainability when compared to other European states, which are running much larger debt margins. Furthermore, a recent agreement between Armenia and the World Bank intends to facilitate the repayment with minimal disturbance to Armenia’s foreign exchange reserves.

It should be noted that sustained external debt does not automatically spell disaster for an economy, but on the contrary, and somewhat paradoxically, could be seen as a sign of healthy economic growth. If creditors continue to approve loans to a country, it displays a certain trust in its economy, thus fostering a better investment climate. This is further supported by the report released by Fitch Ratings, which gave Armenia a BB- credit rating, while predicting a stable economic outlook for the country. The report states: “The rating affirmation reflects the fact that Armenia is gradually reducing its fiscal and external imbalances. The government narrowed the fiscal deficit to 2.8% of GDP in 2011 from 5% of GDP in 2010, through tax collection improvements, revenue surprises and spending restraint”. (Reuters, August 2012)

Furthermore, a recent IMF report released after a September 2012 working visit to Armenia found that Armenia’s debt and inflation management was quite sound, stating that “the programme is broadly on track, with most quantitative targets met and structural benchmarks implemented. Fiscal consolidation is moving forward, ensuring that public debt remains sustainable.” (IMF country report, Armenia October 2012) Furthermore, it praised the Central Bank of Armenia (CBA) for its close monitoring of the situation.

The IMF report also states that the banking sector remains solid and well-capitalised. However, the findings concur with the FPA report in warning that continued foreign currency lending continues to grow rapidly, exposing banks to indirect credit risks. These concerns, however, are factored into the Fund’s technical assistance programme to Armenia, which includes plans for supporting strong growth and poverty reduction, reduction of the fiscal deficit by over 6% of GDP (while trying to preserve key social expenditures), implementing reforms to improve the tax system, ensuring greater exchange rate flexibility, strengthening the financial sector, and more importantly, improving the business environment.

To sum, though the FPA does fear that Armenia’s external debt might be quite critical, it remains quite manageable, according to international financial organisations, which are closely monitoring it, and working along side the CBA to reduce it.

Corruption and Economic Growth

The FPA report is evidently correct in highlighting the negative effect of corruption for the state revenue collection system, as well as for economic growth. In recent years, the government has taken a number of steps to greatly reduce petty corruption, but have categorically failed, or proved unwilling to fight it on a large-scale.

This is highly critical because, even with a 20% corporate profit tax, as well as newer systems implemented to impede tax evasion in small and medium enterprises, tax revenue has only slightly risen, and still only constitutes some 16% of Armenia’s GDP (compared to 25% in neighbouring Georgia. This is largely due to an entrenched system of corruption in the higher echelons of power, where big businesses are intrinsically connected to people in government who often receive kickbacks in exchange for large-scale tax evasion by some of Armenia’s largest corporations. Such practices deprive the government of a large amount of funds which could be used for social or infrastructure programmes, and instead, constrains the government into taking out loans to balance the budget. The problem is further compounded by the fact that many of these government-connected oligarchs enjoy de facto monopolies on commodities imports (often while circumventing the tax system) and go so far as to use the aforementioned connections to threaten foreign investors (and as such, real sources of tax revenue) from establishing themselves in Armenia. Corruption in the government business environments pose a long-term vital threat to the survival of Armenia as a functioning state because it discourages foreign investment and repatriation from the Diaspora. Recent rumours of Republican MP Samvel Aleksanyan’s attempts to fend off french conglomerate “Carrefour”s establishment in Armenia due to fears of competition with his own chain of “City” hypermarkets paint a good picture of how such practices are negative for the country’s development.

In the last couple of years, the government, under pressure from the World Bank, has seemingly taken steps to fight corruption with some success. New regulations make it harder for business transactions to go unregistered, and the tax service has become more transparent. However some would argue that the state’s supposed commitment to fighting corruption is also being used as a way to apply selective justice to enemies of the regime, exemplified by the National Security Services (NSS)’s highly publicised investigation into alleged money laundering by prominent opposition MP Vartan Oskanian.

Role for the Diaspora:

Diaspora investors have had a number of experiences while investing in Armenia. Though many have done well, there are many horror stories now circulating in diaspora circles, causing many to think twice before investing in their home country.

There are two sides to this issue. The first obviously involves government connected personalities taking advantage of a situation where good-hearted yet somewhat naive Diaspora Armenians would often be induced into giving kick-backs and other forms of corruption, or signing legally dubious contracts only to find their assets at the mercy of corrupt judges.

On the other hand, many Diaspora investors were seemingly unaware that, though Armenia is indeed their homeland, it is still a transitional post-Soviet state, and Rule of Law is a new, and ill-understood concept. Thus, smart investors should put aside the emotional bonds of kinship and apply the same risk calculations as they would in any other developing state.

Either way, this creates a vicious circle where government-connected oligarchs receive positive stimulation from continuing the Soviet legacy leeching off of foreign grants, donations and investments, who inevitably end up biting the hand that feeds them, so to speak.

Armenia has been independent for over two decades now, and both the Armenians in Armenia and those of the Diaspora have now passed the episodes of early culture-shock and should now reevaluate their symbiotic relationship. The Armenian diaspora should still invest in Armenia, but not as naively as before, and should not be afraid to demand real change from authorities.

Furthermore, the State would learn that it is in its benefit to take real steps to facilitate and encourage foreign investments, as it offers the prospects of long term growth and wealth than sheer theft would ever account for.

Conclusions:

Though the PFA report does indeed seem to be alarmist, it does point out some glaring and easily amendable inefficiencies in Armenia’s reform programme. Though Armenia’s economic recovery is still quite fragile, It seems unlikely that Armenia would go bankrupt anytime soon, but fear of financial meltdown should not be the driving force behind comprehensive financial and socioeconomic reform.

The Diaspora does have a great role to play in Armenia’s economic recovery and further development which does not involve charity or Genocide lobbying. It involves a combination of smart investment, collective lobbying for REAL justice system reform to protect said investment, and finally, repatriation.

Repatriation is eventually the most important because it would force the local authorities to face citizens who grew up in societies where rule of law is prevalent, and individuals are taught to demand their rights. Such values which would be transmittable to the local population as well.

The government, on its hand, should learn that, though Armenia’s geopolitical situation is not ideal, facilitating investments by lowering corporate and income taxes, creating a strong banking system, aggressive democratisation and committing to free-trade agreements could only result in stronger and more viable state, which in turn would encourage repatriation of a highly skilled and wealthy workforce to the country, thus securing a future for the Armenian nation.